China move like history in slow-motion

By J Saft
June 22, 2010

Asked about 175 years after the fact what he made of the French Revolution, Chinese Premier Zhou Enlai is said to have thought for a moment and concluded: “It is too soon to tell.”

Tell a U.S Congressman up for reelection or an unemployed auto parts worker in Ohio the same thing about China’s new policy to give the yuan more latitude in how it trades against the dollar and, once you’ve picked yourself up off the ground, you’ll have a different answer.

China on Saturday said it would end the yuan’s currency peg to the dollar, allowing it to trade more freely. It also made clear that no big move was forthcoming, preparing the way instead for “gradual” appreciation.

From a Zhou Enlai-like Olympian perspective this is a move in the right direction and, probably, helps to set the stage for a slow-moving but profound transformation in China’s economy and how it interacts with the rest of the world.

This is positive on many levels; it spreads the effects of Chinese growth more widely, it helps, at least a little, to rebalance global trade and, though they won’t be thankful for it, it gives U.S. consumers one more reason to not stuff itself with subsidized goods they so manifestly cannot afford.

What it is not is nearly fast enough.

While the yuan on Monday moved the most since its 2005 revaluation, analysts are generally forecasting a 5 percent appreciation in the coming year. Financial markets are looking for considerably less; offshore futures on Monday were betting on only a 2.6 percent move in the same period.

If you accept the analysis of the Peterson Institute that the yuan is 24 percent undervalued, then we could be looking at nearly a decade before we reach something like a fair rate of exchange.

I don’t think that is nearly soon enough to escape a prospectively very nasty round of trade tensions, tensions that may start between the United States and China but do not have to be limited to that thorny relationship. Regardless of the great drift of history, the U.S. unemployment rate is still going to be something close to 10 percent come the election this autumn.

By the time the yuan actually appreciates by 25 percent, the United States would have a very serious long-term unemployment issue. While it is clear that this was a hard won concession ahead of the Group of 20 meeting, you can expect congressional rhetoric to shift up a gear in very short order.


To be sure, the yuan is already up 3.8 percent so far this year on a trade-weighted basis, courtesy of a shrinking euro. But while this may make Chinese officials loath to take big steps, it is actually one of the principal arguments for why they ought to act more quickly.

The world is in a period where the principal threats are deflation and huge capacity under-utilization.

The recession in the weaker parts of the euro zone currently being engineered to stave off a financing crisis means that pressure in the coming year over who sells what to whom will only grow. China would do well to not use Europe as an excuse, but rather try to get out in front.

Analysis of how much we should expect by way of yuan appreciation seems mostly to be rooted in the experience of 2005, when a revaluation of the yuan ushered in a one-year move of 3.6 percent and a two-year appreciation of a little less than 8 percent.

However 2005 was a very different time and China should not expect what played then to play now. The world was booming, U.S. unemployment was a shade over 6 percent and the talk in the euro zone was of convergence rather than a desperate fight to not break apart.

“Unless there is a fundamental change in China’s mode of development, it will be difficult to see the world not slipping into increased protectionism and every country/region having to fend for itself,” Diana Choyleva of Lombard Street Research wrote to clients.

“Even the Great Recession and China’s decisive domestic demand recovery were not able to do more than cut China’s current account surplus to 5.8 percent of GDP in 2009 from a peak of 10.6 percent of GDP in 2007.”

Expect too for the initial euphoria in financial markets to dissipate quickly as politics and reality intrude.
China has done fantastically out of globalization, but has been lucky enough to do it mostly on its own terms.

That luck might not hold.


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Dear Mr. Saft:

Without a fix to America’s saving problem—highly unlikely in an era of trillion dollar federal budget deficits—forcing the Chinese to appreciate the RMB versus the dollar, or imposing trade sanctions on them if they don’t, is like rearranging the deck chairs on the Titanic. It would only shift the Chinese piece of the US trade deficit to someone else—most likely to a higher cost producer. That would be the functional equivalent of imposing a tax hike on already hard-pressed middle class workers. Washington needs to rethink a flawed strategy of attempting to fix America’s multilateral international imbalance through a bi-lateral currency adjustment. It is bad politics driving bad economics…. Stephen Roach, Chairman of Morgan Stanley Asia
You and Sen. Schumer make it ALL sound so simple. Let the renminbi appreciate and the world’s economic problems will be solved. Yet, if you would stop and think about it, this is a distinctly implausible claim. The idea that an adjustment in one relative price in the entire global economy will rid the world of imbalances and lead to a new economic nirvana doesn’t really make sense. when the Japanese tried to do in the late-1980s exactly what is now being asked of China—shift away from export-led to domestic demand-led growth—it all ended in tears.
It is wrong to insist that China’s global rebalancing imperatives should be addressed by a realignment in a bi-lateral exchange rate with the dollar. What matters most insofar as global imbalances are concerned is China’s broad multilateral exchange rate. On that basis, China can hardly be accused of manipulation vis-a-vis the rest of the world. In real terms, the trade-weighted renminbi is up 7.5% over the past six months and fully 20% over the past five years.
My advice is to leave China alone. They have navigated high and low seas with admirable dexterity. Instead, you and the rest of the elitist journalists should strain to find ways to redirect the declining fiscal firepower of the west to reactivate domestic credit. Domestic credit is the major channel for ensuring that the necessary fiscal adjustment does not end up in even more tears.
Get schooled… It’s educational.

Posted by edgyinchina | Report as abusive

Yes, leaving China alone is a great suggestion by edgyinchina, and by that I would add; completely alone. Manipulation is by definition to manually determine an outcome, which otherwise should be left to neutral mechanisms that are designed to be universally fair. By all definitions, China manipulates its currency, even it it has been unable through its manipulation to actually keep the broad multilateral exchange rate constant, which is something completely unacheivable by the most manupulative of governement. The fail at that does not have the slightest redempting effect for China. It only shows an obvious limitation to their controlling ways. Furthermore, China has targetted what it could. It pegged itself onto the USA, and it is impossible for her to be pegged on both the USA and on the Euro.

Please don’t get schooled Mr. Saft, remain humble and realistic.

Thank you for a fine and well researched article.

Posted by Neander | Report as abusive

It seems that everybody,on each and every financial site is accusing China as a valuta manipulator,or slow runner.I kindly beg to differ on that!

Let us go back in 2005 in a really different world I agree,and the begining of THE GREAT BACKSTREET DEAL, JULY 2005-JULY 2008 never seen,never heard of it.

Monday,JULY the 11th to Friday,JULY the 15th, a USD loss of 2% in a single week.That was a direct “money on the table” act of good intentions,greetings from CNY.At the end of 2005, a total of 2,5% greetings were sent.And counting 5,57% end 2006 11,57% end 2007, to stop in
JULY 2008 at 18% or put it roughly: 15000 pips later landing at the agreed quote of 6,8200 CNY/USD.Valid until today.

I do not remember the financial press reporting of this project,very well carried out by BOTH parts.Smoothly, with no hickups,with mathematic precision.

Consequently,at the end of the project,in JULY 2008,all majors were driven to their “all time high”.Some colateral export-gains under these three years?

Immediatly after the CNY/USD “stabilisation”, actually the next month,all majors,EUR included begin to collapse.Guess how much…right,exactly… 18-19% each!

An american Robin Hood story was born!Take from the rich and give to the poor in order to be able to buy from me!

And look at those poor European guys blaming one another about the fall of their dear,dear child!Sorry guys!

And now let`s buy some houses!Our greenback is king again!

Posted by webcom | Report as abusive